$A on the cusp of a 10-year low

The Australian dollar skidded toward a 10-year low on Tuesday after the Reserve Bank signalled that interest rates are set to fall further and that lower rates could arrive sooner rather than later.

The currency fell to US68.37¢, heading toward an intraday low of US68.27¢ hit at the start of 2016. Once it breaches that level, the next stop – excluding last January's flash crash – is US67.89¢ touched in March 2009.

“The market may have underpriced for the risk of a July move,” said Ray Attrill, head of foreign exchange strategy at National Australia Bank.

The Reserve Bank also talked about the Australian dollar’s role as one of the main channels through which lower interest rates can support the Australian economy.

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“In the current environment, the main channels through which lower interest rates would support the economy were a lower value of the exchange rate, reduced borrowing rates for businesses, and lower required interest payments on borrowing by households,” Dr Lowe commented.

A weaker currency supports economic growth by helping the country’s export sector and encouraging tourism. Hasan Tevfik, equity strategist at independent research house MST Marquee, commented that if Australia is a more attractive destination for tourists, then companies such as airline Qantas, airport operator Sydney Airport, and casino operators, could benefit as the currency falls.

Another aspect of a weaker Australian dollar, in combination with extremely low bond yields for many developed markets, is that Australian companies could become more attractive to offshore buyers, the strategist said.

“A weaker Australian dollar in combination with low global debt could make Australian companies more vulnerable to cross-border merger and acquisitions,” he said.

Record low

The 10-year government bond yield hit a record low of 1.365 per cent after the minutes.

Philip Lowe has signalled more interest rate cuts. Peter Braig

Market expectations that interest rates would be lowered sooner rather than later were also sharpened by some of the wording in Tuesday’s minutes.

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National Australia Bank’s chief markets economist Ivan Colhoun noted that the minutes contained “perhaps the longest ever considerations for monetary policy section” in Reserve Bank history and also included the phrase “in the period ahead”.

Historically, that phrase “has been associated with monetary policy action within a one to three-month timeframe and usually within one to two months”, Mr Colhoun said. “As such, while there are no discrete clues as to a follow up move in July, we remain on high alert for a further cut by August,” he said.

Sean Callow, senior currency strategist at Westpac made a similar point. “In the May minutes, the phrase ‘the period ahead’ only meant one month,” he noted, with the Reserve Bank cutting the cash rate in June.

“I really don’t blame the market for putting the chance of a rate cut in July at 50:50,” he said. Westpac expects the currency to finish the year at US68¢, roughly the level where it currently trades.

But Mr Attrill at National Australia Bank, said that he’s expecting a rebound in the Australian dollar to US73¢ by the end of the year. That forecast hinges on his view of the US currency, which Mr Attrill is expecting to soften as the year progresses.

Risk of more downside

At the same time, if the Federal Reserve proves reluctant to take a dovish tone on interest rates “then there could be more downside for the Australian dollar”, Mr Attrill noted.

Another key risk for the Australian dollar is that China allows its currency to weaken. If that happens, that will spill over to emerging market currencies and likely drive risk-off selling in the Australian dollar, he said.

Markets had not been expecting much further detail around the future direction of interest rates from the minutes on Tuesday, given that Dr Lowe had made a speech about interest rates and the economy on the same day as the rate cut was announced.

On June 4, the Reserve Bank slashed the official cash rate by 25 basis points to a fresh record low of 1.25 per cent. That was the first change to the cash rate since August 2016.

Dr Lowe later told an audience that “the board has not yet made a decision, but it is not unreasonable to expect a lower cash rate”.